Question 1

An efficient portfolio is one that does which of the following?
A)offers the highest return for the lowest possible cost
B)provides an evenly weighted portfolio of diverse assets
C)eliminates all risk while providing an expected positive rate of return
D)lies on the vertical axis when graphing expected returns against standard deviation
E)offers the highest return for a given level of risk

Accepted Answer

An efficient portfolio is one that offers the highest return for a given level of risk, which is known as the "efficient frontier" on a graph of expected returns against standard deviation. An evenly weighted portfolio of diverse assets (B) may not necessarily be efficient and eliminating all risk while providing an expected positive rate of return (C) is not feasible. While minimizing costs is important, it is not the defining characteristic of an efficient portfolio (A).

Question 2

You own a stock which is expected to return 14% in a booming economy and 9% in a normal economy. If the probability of a booming economy decreases, your expected return will:
A)decrease.
B)either remain constant or decrease.
C)remain constant.
D)increase.
E)either remain constant or increase.

Accepted Answer

Since the stock is expected to return a higher amount in a booming economy than in a normal economy, if the probability of a booming economy decreases, the overall expected return of the stock will decrease. Therefore, the best choice is A.

Question 3

You own a stock that will produce varying rates of return based upon the state of the economy. Which one of the following will measure the risk associated with owning that stock?
A)weighted average return given the multiple states of the economy
B)rate of return for a given economic state
C)variance of the returns given the multiple states of the economy
D)correlation between the returns given the various states of the economy
E)correlation of the weighted average return as compared to the market

Accepted Answer

The variance of the returns given the multiple states of the economy will measure the risk associated with owning the stock. This is because the variance measures the degree of variation of the returns from the expected value, which in turn measures how much the returns deviate from the average. The greater the deviation, the greater the risk.

Question 4

Correlation is the:
A)squared measure of a security's total risk.
B)extent to which the returns on two assets move together.
C)measurement of the systematic risk contained in an asset.
D)daily return on an asset compared to its previous daily return.
E)spreading of an investment across a number of assets.

Accepted Answer

Correlation measures the extent to which the returns on two assets move together. It is a statistical measure that ranges from -1 to +1, where -1 means the returns move in opposite directions, 0 means no correlation, and +1 means the returns move in the same direction.

Question 5

The division of an investor's portfolio dollars among various types of assets is referred to as:
A)the minimum variance portfolio.
B)the efficient frontier.
C)correlation.
D)asset allocation.
E)setting the investment opportunities.

Accepted Answer

Asset allocation refers to dividing an investor's portfolio dollars among various types of assets, such as stocks, bonds, and cash, with the goal of balancing risk and return. This strategy can help diversify an investor's holdings and minimize overall portfolio risk.

Question 6

What is the extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset?
A)efficient return
B)correlated value
C)risk premium
D)expected return
E)realized return

Accepted Answer

The compensation for investing in a risky asset is called a risk premium, which is the additional return an investor demands for taking on higher risk. This premium is added to the risk-free rate of return to calculate the expected return of a risky asset. The options A, D, and E are not relevant in this context, and there is no such term as "correlated value" in finance.

Question 7

If the future return on a security is known with absolute certainty, then the risk premium on that security should be equal to:
A)zero.
B)the risk-free rate.
C)the market rate.
D)the market rate minus the risk-free rate.
E)the risk-free rate plus one-half the market rate.

Accepted Answer

If the future return on a security is known with absolute certainty, then there is no risk involved in investing in that security. Therefore, investors would not require any premium for taking on risk, and the risk premium would be zero.

Question 8

Which of the following affect the expected rate of return for a portfolio?
I. weight of each security held in the portfolio
II. the probability of various economic states occurring
III. the variance of each individual security
IV. the expected rate of return of each security given each economic state
A)I and IV only
B)II and IV only
C)II, III, and IV only
D)I, II, and IV only
E)I, II, III, and IV

Accepted Answer

The weight of each security held in the portfolio (I) affects the expected rate of return as it determines the overall exposure of the portfolio to each security. The probability of various economic states occurring (II) affects the expected rate of return as it determines the likelihood of each security performing well or poorly. The expected rate of return of each security given each economic state (IV) affects the expected rate of return as it provides insight into how the security will perform under different economic conditions. The variance of each individual security (III) affects the risk of the portfolio, but not necessarily the expected rate of return. Therefore, the best choice is D, I, II, and IV only.

Question 9

Which of the following are affected by the probability of a state of the economy occurring?
I. expected return of an individual security
II. expected return of a portfolio
III. standard deviation of an individual security
IV. standard deviation of a portfolio
A)I and III only
B)I and II only
C)II and IV only
D)III and IV only
E)I, II, III, and IV

Accepted Answer

The probability of a state of the economy occurring affects all listed items: the expected return and standard deviation of both individual securities and portfolios. Expected returns are calculated based on the weighted average of possible outcomes, where probabilities are the weights. Standard deviation measures the dispersion of returns, which also depends on the probabilities of different states of the economy.

Question 10

You own a portfolio of 5 stocks and have 3 expected states of the economy. You have twice as much invested in Stock A as you do in Stock E. How will the weights be determined when you compute the rate of return for each economic state?
A)The weights will be the probability of occurrence for each economic state.
B)Each stock will have a weight of 20% for a total of 100%.
C)The weights will decline steadily from Stock A to Stock E.
D)The weights will be based on the amount invested in each stock as a percentage of the total amount invested.
E)The weights will be based on a combination of the dollar amounts invested as well as the economic probabilities.

Accepted Answer

The weights will be based on the amount invested in each stock as a percentage of the total amount invested. This method is commonly referred to as the market value weights. Since the question states that there is twice as much invested in Stock A as in Stock E, the weights will not be equal and will be based on the dollar amounts invested. The economic probabilities are not mentioned as a factor in determining the weights, so option E is not the best choice. Option A is incorrect because the weights are not solely based on the probability of occurrence for each state. Option B is incorrect because the weights are not equal. Option C is incorrect because there is no information given to suggest that the weights decline steadily from Stock A to E.

Question 11

Which one of the following statements must be true?
A)All securities are projected to have higher rates of return when the economy booms versus when it is normal.
B)Considering the possible states of the economy emphasizes the fact that multiple outcomes can be realized from an investment.
C)The highest probability of occurrence must be placed on a normal economy versus either a boom or a recession.
D)The total of the probabilities of the economic states can vary between zero and 100%.
E)Various economic states affect a portfolio's expected return but not the expected level of risk.

Accepted Answer

Considering the possible states of the economy emphasizes the fact that multiple outcomes can be realized from an investment. This is a fundamental principle of investment analysis and is true regardless of the specific securities or economic conditions being considered. The other statements are either incorrect (such as A, C, and D) or incomplete (such as E, which does not mention how economic states affect risk).

Question 12

The value of an individual security divided by the total value of the portfolio is referred to as the portfolio:
A)beta.
B)standard deviation.
C)balance.
D)weight.
E)variance.

Accepted Answer

The value of an individual security divided by the total value of the portfolio is referred to as the weight of that security in the portfolio. This is because it represents the proportion or "weight" of the portfolio that is allocated to that particular security.

Question 13

You own three securities. Security A has an expected return of 11% as compared to 14% for Security B and 9% for Security C. The expected inflation rate is 4% and the nominal risk-free rate is 5%. Which one of the following statements is correct?
A)There is no risk premium on Security C.
B)The risk premium on Security A exceeds that of Security B.
C)Security B has a risk premium that is 50% greater than Security A's risk premium.
D)The risk premium on Security C is 5%.
E)All three securities have the same expected risk premium.

Accepted Answer

The risk premium is calculated as the expected return minus the nominal risk-free rate. Security A's risk premium is 6% (11% - 5%), and Security B's risk premium is 9% (14% - 5%). Security B's risk premium is 50% greater than Security A's risk premium (9% is 50% more than 6%).

Question 14

You own a portfolio comprised of 4 stocks and the economy has 3 possible states. Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5%, regardless of the economic state. Given this, what must be value of the portfolio's variance be?
A)negative, but not −1
B)−1.0
C)0
D)1.0
E)positive, but not +1

Accepted Answer

According to the question, the expected rate of return is the same regardless of the economic state. This means that the portfolio is not affected by any changes in the economy and is a risk-free portfolio. The variance of a risk-free portfolio is always zero. Therefore, the value of the portfolio's variance must be zero.

Question 15

Which of the following will increase the expected risk premium for a security, all else constant?
I. an increase in the security's expected return
II. a decrease in the security's expected return
III. an increase in the risk-free rate
IV. a decrease in the risk-free rate
A)I only
B)III only
C)IV only
D)I and IV only
E)II and III only

Accepted Answer

The expected risk premium for a security is calculated as the difference between the security's expected return and the risk-free rate. Therefore, an increase in the security's expected return (I) or a decrease in the risk-free rate (IV) would both increase the expected risk premium, all else constant.

Question 16

Which one of the following is a collection of possible risk-return combinations available from portfolios consisting of individual assets?
A)minimum variance set
B)financial frontier
C)efficient portfolio
D)allocated set
E)investment opportunity set

Accepted Answer

The investment opportunity set is a collection of possible risk-return combinations available from portfolios consisting of individual assets. It represents all the feasible combinations of risk and return that an investor can achieve by creating portfolios from a given set of assets.

Question 17

Terry has a portfolio comprised of two individual securities. Which one of the following computations that he might do is NOT a weighted average?
A)correlation between the securities
B)individual security expected return
C)portfolio expected return
D)portfolio variance
E)portfolio beta

Accepted Answer

Correlation between securities is not computed by taking a weighted average. Instead, it measures the degree of association or relationship between the returns of the two securities. The other computations listed (expected return, portfolio expected return, portfolio variance, and portfolio beta) all involve calculating a weighted average of some sort, whether it be of individual security returns or security weights within the portfolio.

Question 18

Which one of the following is the set of portfolios that provides the maximum return for a given standard deviation?
A)minimum variance portfolio
B)Markowitz efficient frontier
C)correlated market frontier
D)asset allocation relationship
E)diversified portfolio line

Accepted Answer

The Markowitz efficient frontier is the set of portfolios that provides the maximum return for a given level of risk (or standard deviation). It represents the optimal portfolio choices for an investor seeking to maximize their returns while minimizing their risk.

Question 19

A group of stocks and bonds held by an investor is called which one of the following?
A)weights
B)grouping
C)basket
D)portfolio
E)bundle

Accepted Answer

A group of stocks and bonds held by an investor is commonly referred to as a portfolio. The other choices do not accurately describe this type of investment holding.

Question 20

The principal of diversification involves investing in a variety of assets with which one of the following being the primary goal?
A)increasing returns
B)minimizing taxes
C)reducing some of the risk
D)eliminating all of the risk
E)increasing the variance

Accepted Answer

The primary goal of diversification is to reduce some of the risk involved in investing by spreading investments across different asset classes. It is not necessarily aimed at increasing returns, minimizing taxes, eliminating all risk, or increasing variance.

Quiz 11: Diversification and Risky Asset Allocation

An efficient portfolio is one that does which of the following?

You own a stock which is expected to return 14% in a booming economy and 9% in a normal economy. If the probability of a booming economy decreases, your expected return will:

You own a stock that will produce varying rates of return based upon the state of the economy. Which one of the following will measure the risk associated with owning that stock?

Correlation is the:

The division of an investor's portfolio dollars among various types of assets is referred to as:

What is the extra compensation paid to an investor who invests in a risky asset rather than in a risk-free asset?

If the future return on a security is known with absolute certainty, then the risk premium on that security should be equal to:

Which of the following are affected by the probability of a state of the economy occurring? I. expected return of an individual security II. expected return of a portfolio III. standard deviation of an individual security IV. standard deviation of a portfolio

You own a portfolio of 5 stocks and have 3 expected states of the economy. You have twice as much invested in Stock A as you do in Stock E. How will the weights be determined when you compute the rate of return for each economic state?

Which one of the following statements must be true?

The value of an individual security divided by the total value of the portfolio is referred to as the portfolio:

You own three securities. Security A has an expected return of 11% as compared to 14% for Security B and 9% for Security C. The expected inflation rate is 4% and the nominal risk-free rate is 5%. Which one of the following statements is correct?

You own a portfolio comprised of 4 stocks and the economy has 3 possible states. Assume you invest your portfolio in a manner that results in an expected rate of return of 7.5%, regardless of the economic state. Given this, what must be value of the portfolio's variance be?

Which of the following will increase the expected risk premium for a security, all else constant? I. an increase in the security's expected return II. a decrease in the security's expected return III. an increase in the risk-free rate IV. a decrease in the risk-free rate

Which one of the following is a collection of possible risk-return combinations available from portfolios consisting of individual assets?

Terry has a portfolio comprised of two individual securities. Which one of the following computations that he might do is NOT a weighted average?

Which one of the following is the set of portfolios that provides the maximum return for a given standard deviation?

A group of stocks and bonds held by an investor is called which one of the following?

The principal of diversification involves investing in a variety of assets with which one of the following being the primary goal?